Asset Classes: Correlations


Kerry Back

BUSI 721, Fall 2022
JGSB, Rice University

Real Estate

The reason an investor should consider other asset classes in addition to stocks is diversification.

  • Diversification is ineffective if assets move exactly together.
  • It is more effective when asset returns are less correlated.
  • So, correlation of asset classes is a key issue.

Let’s look at stocks, Treasury bonds, corporate bonds, and gold over a long time horizon.

And look at a broader set of assets over a shorter time horizon using ETFs.

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Correlation with Inflation

An uptick in inflation is generally accompanied by falling asset markets.

Is there an asset that hedges inflation - doing better when inflation is high?

Let’s look at stocks, bonds, and gold.

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The average real return of an asset is a very different issue than whether it hedges inflation.

Asset A has a higher geometric average real return than asset B if, and only if, asset A has a higher geometric average nominal return.

It doesn’t matter for this calculation whether A or B hedges inflation.

So, we’re switching topics, but let’s look at real returns of stocks, bonds, and gold.

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